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TABLE 1-2 Your Spending, Now and After Your Home Purchase

      Tabulating your spending is only half the battle on the path to fiscal fitness and a financially successful home purchase. After all, many government entities know where they spend our tax dollars, but they still run up massive levels of debt! You must do something with the personal spending information you collect.

      When most Americans examine their spending, especially if it’s the first time, they may be surprised and dismayed at the amount of their overall spending and how little they’re saving. How much is enough to save? The answer depends on your goals and how good your investing skills are. For most people to reach their financial goals, they must annually save at least 10 percent of their gross (pretax) income.

      From Eric’s experience as a personal financial counselor and lecturer, he knows that most people don’t know how much they’re currently saving, and even more people don’t know how much they should be saving. You should know these amounts before you buy your first home or trade up to a more costly property.

      If you’re like most people planning to buy a first home, you need to reduce your spending to accumulate enough money to pay for the down payment and closing costs and create enough slack in your budget to afford the extra costs of homeownership. Trade-up buyers may have some of the same issues as well. Where you decide to make cuts in your budget is a matter of personal preference. Here are some proven ways to cut your spending now and in the future:

      Most people find it enlightening to see how much they need to save to accomplish particular goals. For example, wanting to retire while you still have good health is a common goal. And the good news is that you can take advantage of tax incentives while you save toward retirement.

      Money that you contribute to an employer-based retirement plan – for example, a 401(k) – or to a self-employed plan – for example, a SEP-IRA – is typically tax deductible at both the federal and state levels. Also, after you contribute money into a retirement account, the gains on that money compound over time without taxation.

      

If you’re accumulating down-payment money for the purchase of a home, putting that money into a retirement account is generally a bad idea. When you withdraw money prematurely from a retirement account, you owe not only current income taxes but also hefty penalties – 10 percent of the amount withdrawn for the IRS plus whatever penalty your state collects.

      If you’re trying to save for a real estate purchase and save toward retirement and reduce your taxes, you have a dilemma – assuming that, like most people, you have limited funds with which to work. The dilemma is that you can save outside of retirement accounts and have access to your down-payment money but pay much more in taxes. Or you can fund your retirement accounts and gain tax benefits, but lack access to the money for your home purchase.

      You have two ways to skirt this dilemma:

      Because most people have limited discretionary dollars, you must decide what your priorities are. Saving for retirement and reducing your taxes are important goals; but when you’re trying to save to purchase a home, some or most of your savings needs to be outside a tax-sheltered retirement account. Putting your retirement savings on the back burner for a short time to build up your down-payment cushion is fine. However, be sure to purchase a home that offers enough slack in your budget to fund your retirement accounts after the purchase.

      Most people borrow money for a simple reason: They want to buy something they can’t afford to pay for in a lump sum. How many 18-year-olds and their parents have the extra cash to pay for the full cost of a college education? Or prospective homebuyers to pay for the full purchase price of a home? So people borrow.

      When used properly, debt can help you accomplish your financial goals and make you more money in the long run. But if your financial situation allows you to make a larger than necessary down payment, consider how much debt you need or want. With most lenders, as we discuss in Chapter 5, you’ll get access to the best rates on mortgage loans by making a down payment of at least 20 percent. Whether or not making a larger down payment makes sense for you depends on a number of factors, such as your other options and goals.

      The potential rate of return that you expect or hope to earn on investments is a critical factor when you decide whether to make a larger down payment or make other investments. Psychologically, however, some people feel uncomfortable making a larger down payment because it diminishes their savings and investments.

      You probably don’t want to make a larger down payment if it depletes your emergency financial cushion. But don’t be tripped up by the misconception that somehow you’ll be harmed more by a real estate market crash if you pay down your mortgage. Your home is worth what it’s worth – its value has nothing to do with the size of your mortgage.

      Financially, what matters in deciding to make a larger down payment is the rate of interest you’re paying on your mortgage versus the rate of return your investments are generating. Suppose that you get a fixed-rate mortgage at 6 percent. To come out financially ahead making investments instead of making a larger down payment, your investments need to produce an average

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